Merger of GETCO and Knight

9 Months Ended

Sep. 30, 2013

Business Combinations [Abstract]

Merger With GETCO and Knight

Merger of GETCO and Knight

Background

Pursuant to the Merger Agreement, upon completion of the Mergers, subject to proration and certain specified exceptions, each outstanding share of Knight Class A common stock, par value $0.01 per share (“Knight Common Stock”) was converted into the right to elect to receive either $3.75 per share in cash or one third of a share of KCG Class A common stock, par value $0.01 per share (“KCG Class A Common Stock”). Pursuant to the proration procedures provided in the Merger Agreement and taking into account the waiver by Jefferies LLC, Knight's largest stockholder before the Mergers, of its right to receive cash consideration with respect to certain of its shares, former Knight stockholders eligible for election received a cash payment of approximately $720.0 million.

Upon completion of the Mergers, GETCO unitholders received, in aggregate, 75.9 million shares of KCG Class A Common Stock and 24.3 million warrants to acquire shares of KCG Class A Common Stock. The warrants comprise 8.1 million Class A warrants, having a $12.00 exercise price and exercisable for a four-year term; 8.1 million Class B warrants, having a $13.50 exercise price and exercisable for a five-year term; and 8.1 million Class C warrants, having a $15.00 exercise price and exercisable for a six-year term (collectively the “KCG Warrants”).

Upon completion of the Mergers, Knight's stockholders received, in the aggregate, $720.0 million in cash and 41.9 million shares of KCG Class A Common Stock. After taking into account the election results and the shares of KCG Class A Common Stock issued to former unitholders of GETCO and former stockholders of Knight, 116.8 million shares (including unvested restricted stock units ("RSUs")) of KCG Class A Common Stock were outstanding as of July 1, 2013.

Accounting treatment of the Mergers

The Mergers are accounted for as a purchase of Knight by GETCO under accounting principles generally accepted in the United States of America ("GAAP") based on, among other factors, the controlling ownership position of the former GETCO unitholders as of the closing of the Mergers. Under the purchase method of accounting, the assets and liabilities of Knight, as of July 1, 2013 were recorded at their respective fair values and added to the carrying value of GETCO's existing assets and liabilities. The reported financial condition and results of operations of KCG for the periods following the Mergers reflect Knight's and GETCO's balances and reflect the impact of purchase accounting adjustments, including revised amortization and depreciation expense for acquired assets. As GETCO is the accounting acquirer, the financial results for KCG for the nine months ended September 30, 2013 comprise third quarter results of KCG and the results of GETCO for the six months ended June 30, 2013. All periods prior to 2013 comprise solely the results of GETCO.

Prior to the Mergers, GETCO treated its investment in Knight as an available-for-sale security, which it recorded at fair value, with any gains or losses recorded in other comprehensive income within equity. On the acquisition date, as a result of the Mergers, the Company reversed the cumulative gain that it had recorded in other comprehensive income within equity and recognized a gain of $128.0 million in Investment income and other, net on its Consolidated Statements of Operations for the three and nine months ended September 30, 2013.

All GETCO earnings per share and unit share outstanding amounts in this Quarterly Report on Form 10-Q have been calculated as if the conversion of GETCO units to KCG Class A Common Stock took place on January 1, 2012, at the exchange ratio, as defined in the Merger Agreement. See Footnote 15 "Earnings Per Share".

Purchase price and goodwill

The Knight acquisition was accounted for using the acquisition method of accounting. The aggregate purchase price of $1.37 billion was determined as the sum of the fair value of KCG shares issued to former Knight stockholders at closing; the fair value of Knight employee stock based awards attributable to periods prior to closing; and the fair value of the Knight Common Stock owned by GETCO and its subsidiaries immediately prior to the Mergers (and subsequently canceled in conjunction with the Mergers).

The purchase price has been allocated to the assets acquired and liabilities assumed using their estimated fair values at July 1, 2013, the closing date of the Mergers. The Company has not yet completed all of its analyses to finalize the allocation of the purchase price to the Knight acquired assets and liabilities. The allocation of the purchase price may be modified over the measurement period, as more information is obtained about the fair values of assets acquired and liabilities assumed.

Tax treatment of the Mergers

The Company believes that the Mergers will be treated as a transaction described in Section 351 of the Internal Revenue Code, and both Knight and GETCO have received tax opinions from external legal counsel to that effect. Knight’s tax basis in its assets and liabilities therefore generally carries over to the Company following the Mergers. Upon completion of the Mergers, the Company became a corporation subject to U.S. corporate income taxes and, following the Mergers, the Company recorded deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and measures them using the enacted tax rates and laws that will be in effect when such differences are expected to reverse.

The Company recorded net deferred tax assets of $65.9 million with respect to recording Knight’s assets and liabilities under the purchase method of accounting as described above as well as recording the value of tax net operating losses ('NOLs”) and other tax attributes acquired as a result of the Mergers, as described in Footnote 13 “Income Taxes”. These deferred tax assets are included in Other assets in the table below.

The following table reflects the preliminary allocation of the purchase price to the assets acquired and liabilities assumed at the acquisition date (in thousands):

Identifiable Net Assets
Cash and cash equivalents	$	509,133
Cash and securities segregated under federal and other regulations	203,045
Financial instruments owned	1,937,929
Securities borrowed	1,158,981
Receivable from brokers, dealers and clearing organizations	1,366,974
Fixed assets and leasehold improvements, net	84,596
Investments	106,353
Intangible assets	156,800
Assets within discontinued operations	5,607,063
Other assets	211,735
Total Assets	$	11,342,609
Financial instruments sold, not yet purchased	$	1,512,983
Collateralized financings	1,166,211
Payable to brokers, dealers and clearing organizations	635,914
Payable to customers	527,918
Accrued compensation expense	107,409
Accrued expenses and other liabilities	139,624
Liabilities within discontinued operations	5,518,168
Long-term debt	375,000
Total Liabilities	$	9,983,227
Total identified assets acquired, net of assumed liabilities	1,359,382
Goodwill	13,753
Total Purchase Price	$	1,373,135

Amounts preliminarily allocated to intangible assets, the amortization period and goodwill were as follows (dollars in thousands):

			Amortization
	Amount		Years
Technology	$	110,000	5 years
Customer relationships	35,000		9 - 11 years
Trade names	4,000		10 years
Trading rights	7,800		7 years
Intangible assets	156,800
Goodwill	13,753
Total	$	170,553

Goodwill has been primarily assigned to the Market Making segment of the Company. None of the goodwill is expected to be deductible for tax purposes; however, as described in Tax treatment of the Mergers above, Knight’s tax basis in its assets, including certain goodwill, has carried over to the Company as a result of the Mergers.

The Company recorded $1.2 million and $27.6 million of costs related to the Mergers for the three and nine months ended September 30, 2013, respectively.

Included in KCG results for the three months ended September 30, 2013 are results from the businesses acquired as a result of the Mergers as follows:

	Three months ended September 30,
	2013
Revenues	$	240,805
Income from continuing operations, before income taxes	21,164

	Three months ended September 30, 2012					Nine months ended September 30, 2013					Nine months ended September 30, 2012
	Reported		Pro Forma			Reported		Pro Forma			Reported		Pro Forma
	(in thousands, except per share amounts)
Revenue	$	130,602	$	(120,210	)	$	698,123	$	1,099,518		$	425,241	$	677,955
Net income from continuing operations	9,807		(303,413		)	138,316		(10,494		)	24,556		(274,981		)
Net income	9,807		(387,350		)	137,532		(39,554		)	24,556		(350,831		)
Diluted earnings (loss) per share from continuing operations	$	0.21	$	(6.54	)	$	2.01	$	(0.15	)	$	0.49	$	(5.54	)
Diluted earnings (loss) per share	$	0.21	$	(8.35	)	$	2.00	$	(0.57	)	$	0.49	$	(7.07	)

The pro forma results are based on adding the pre-tax historical results of GETCO and Knight, and adjusting primarily for amortization of intangibles created in the Mergers, debt raised in conjunction with the Mergers and income taxes as if the Company was subject to U.S. corporate income taxes for all periods presented. The pro forma data assumes all GETCO units have been converted to KCG Class A Common Stock on January 1, 2012 and excludes any gain recognized on Knight Common Stock. The pro forma disclosures do not include adjustments to reflect the Company's operating costs or expected differences in the way funds generated by the Company are invested. The pro forma data is intended for informational purposes and is not indicative of the future results of operations.